Although the Jones Act, the United States statute the effectively limits the cabotage trade of the United states to US citizens, has long been a backwater of American maritime legal practice, it is experiencing a bit of a renaissance – or at least a renewed interest. Under the Jones Act, in order to qualify to engage in the coastwise trade of the United States, a vessel must be (i) built in the United States, (ii) 75% owned by United States "citizens", (iii) controlled by United States citizens, (iv) crewed by United States citizens and (v) be documented under United States flag. That all sounds simple enough but in practice it is a lot more complicated. The focus of this note is the citizenship requirement, specifically in the context of a corporate debt restructuring, a topic the relevance whereof has been made clear by the number of recent restructurings of Jones Act companies.
Demonstrating ownership and control can be difficult in the ordinary course, especially for a public company. Now, for a company in financial distress seeking to recapitalize, whether in or out of court, the task is even more complex. Quite often, the financial restructuring of a company – at least a successful one – involves a debt for equity swap whereby certain class of creditors of a struggling company forgive some or all of the debt obligations owing to them in exchange for equity of the company. However, the aforementioned citizen ownership requirements present a significant hurdle to that approach.
Unlike the citizenship requirement for equity ownership, there is no analogous test for debtholders. Moreover, for most companies in distress, there is a fair chance that the debt of those companies has traded in the secondary market and is now owned by a wide array of entities including investment vehicles established in offshore jurisdictions. While there is nothing to prevent these vehicles form holding debt, those that cannot meet the citizenship test imposed by the Jones Act cannot merely convert their debt holdings into equity, unless such conversion keeps non-US ownership below 25% of the total equity outstanding.
An elegant response to this problem developed and fine-tuned over the years is the use of warrants that can be issued to non-citizen debt holders (such warrants have been used in, most recently, Tidewater and GulfMark restructurings). As best as can be, the economic value of the warrants can approximate the value of the shares given to qualifying shareholders (e.g., through the use of a cashless exercise mechanism, dilution protections, ready transferability, etc.). The United States Coast Guard (from whom the prudent practitioner or issuer should seek a private letter ruling approving the form of warrant) has historically focused on whether the warrant holder has any voting rights or other elements of control or any economic rights analogous to dividend rights afforded a stockholder; if neither is present, there is an excellent chance the form of warrant will be approved.
Essentially, the Coast Guard has adopted the view that such warrants are not equity. This is true notwithstanding more conventional views (and certainly that adopted by the Securities and Exchange Commission) that warrants are "equity". Yet, in context, the view taken by the Coast Guard makes perfect sense (and, to be candid, if the Coast Guard had adopted a contrary view, certain restructurings might have ended up as liquidations). And, while control may be an issue in negotiating a restructuring with debtholders, dividends are not an immediate concern. Most affected creditors take the view that by the time any dividends are payable, they will have been able to sell their warrants to a party eligible to exercise them.
The successful use of these warrant structures at the company level presents an interesting further opportunity. That is, if warrants work on the company level to preserve citizenship, could an investment vehicle qualify as a US citizen eligible for stock instead of warrants in a restructuring of a Jones Act company simply by mirroring the stock/warrant structure at the investor level? This is an intriguing prospect worthy of further thought and analysis. If the debtholder transfers the debt to a vehicle with similar ownership but in which qualifying holders were granted stock or its equivalent and non-qualifying holders received warrants, would that not (1) make the restructuring easier to accomplish and (2) broaden the base of US citizen holders of the issuer? This would make it considerably easier for investment funds to participate in the ownership of a Jones Act company.